As Demand Outstrips Supply in Cloud Hubs, Secondary Markets May Benefit

The data center industry continues to experience historic demand for more capacity to support the growth of cloud computing, with record pre-leasing of new projects. But the delivery on some of those new projects could be delayed, as developers face continued disruptions in the supply chain and a shortage of construction workers.

That is likely to shift some requirements to secondary markets, which have more land and power available to support new capacity.

“New data center supply will be impeded by the availability of land and power in many major markets, driving expansion outside the traditional hubs,” JLL writes in its summary of market conditions in the first half of 2022.

Recent market reports by JLL, CBRE and datacenterHawk all describe a red-hot market where developers are struggling to keep up with the demand from both hyperscale operators and enterprise customers. In some key markets, the Internet is growing faster than the electrical infrastructure to support it, while the lingering effects of the COVID-19 pandemic and semiconductor shortage are being felt in the supply chain.

As a result, data center space is likely to become harder to find, and slightly more expensive to lease, according to real estate researchers. This is likely to stimulate growth in second-tier regional markets.

“Data center operators looking to capitalize on hyperscale growth are paying more attention to secondary markets,” writes datacenterHawk in a recent market update. “Areas like Quincy, WA, Minneapolis, MN and Salt Lake City, UT are examples of areas that are attracting both hyperscale users wanting to own and operate their own facilities and data center providers positioning themselves to accommodate future growth.”

The Building Boom Continues Apace

Activity in early 2022 has been accelerated by concerns that delivery of future capacity may be slowed by supply chain disruptions. Hyperscale customers – a group led by Meta, Amazon Web Services, Microsoft and Google – are racing to reserve space to ensure they have room to keep growing.

After a blockbuster first quarter, industry observers wondered whether strong leasing would continue, or large customers were simply trying to order ahead. But research reports for 2Q indicate that the strong leasing has not subsided.

• JLL Research: JLL sees a “historically high volume of preleasing activities U.S. market demand reached 1,087 MW in H1 2022, more than 95% of 2021’s full-year demand. The U.S. data center construction pipeline at the mid-point of 2022 totaled 1,913 MW, which exceeds last year’s total, and has nearly grown by three times on a year-over-year basis.”
• CBRE Insights: “Despite a 20% increase in wholesale colocation supply over the past year, developers can barely keep up with demand,” writes CBRE. “Among primary markets, almost 75% of the 1,456.9 megawatts (MW) of under-construction capacity in H1 is already preleased. In tandem with increased demand, the amount of new supply currently under construction nearly tripled year-over-year in H1. Today’s unprecedented demand is pushing up lease rates in the few areas where there is vacant space.”
• datacenterHawk Market Insight: The demand from the hyperscale sector continues to outpace supply, according to DC. “The North American primary market vacancy is now averaging 4.4%, its lowest point ever,” datacenterHawk’s David Liggitt wrote in a recent market update. “This is the first time the average dropped below 5%. The high demand and low vacancy rate is a good representation of where the overall market in the US and Canada sit today. While there are a few markets with decent capacity available to meet the demand, most are supply constrained with data center operators looking at ways to grow quickly.”

The combination of strong demand and delivery challenges means major markets will mean tighter supply..

“Persistent supply chain delays will continue to cause delivery challenges for the next 24 months,” said JLL. “Many primary markets are now seeing power transmission delivery delays, moratoriums or pushback on development, and lack of available land sites. Because of this, vacancy is expected to decline, especially as development slowdowns persist and create scarcity in the market.”

Opportunity for Second-Tier Markets

Growth in secondary markets was one of the trend DCF highlighted earlier this year.

“In 2022, the capital infusion will extend to regional markets and service providers specializing in ‘second-tier’ cities and edge computing,” we wrote in our 2022 Forecast. “Core markets are getting crowded and competitive, and new investors continue to seek access to attractive returns in digital infrastructure. Regional markets with business growth and clean energy will be clear winners.”

That prediction is being borne out in the current surge of both leasing and construction outside the primary markets.

“While demand continues to grow in primary data center markets, large growth is also occurring in secondary markets,” writes Jacob Fricks of datacenterHawk in a recent update. “Cloud service providers are no exception, as many have decided to set up large campuses in secondary markets, such as Omaha, NE, Des Moines, IA, and Boardman, OR.

“Land cost in secondary markets differs significantly from primary data center markets,” Fricks added. “For example, the average price for one acre in Northern Virginia is over 20 times more expensive than the average of the 3 secondary markets mentioned above. Secondary markets also are attractive because of land availability, less expensive power cost, and a suitable water supply to cool equipment.”